The economic stresses of the Covid-19 pandemic and ongoing shutdowns are taking their toll on renter-by-necessity households. While the prospects of a successful vaccine rollout are encouraging, the many renters who have lost jobs at restaurants, retail establishments, hotels, airlines and other struggling businesses are not going to see an overnight recovery.
The recent collection trends in the multifamily space support this potential for delayed recovery. Trends have been lagging as the Covid-19 pandemic and related CDC eviction moratorium drag on. For example, multifamily industry body NMHC said that 79.2% of U.S. apartment renters had made full or partial payment by February 6, worse than the 81.1% who had paid by February 6, 2020, but better than the 76.6% who had paid through January 6, 2021.
Thus, it seems likely that multifamily apartment fundamentals will remain burdened for much of 2021. This presents an ongoing risk to landlords and multifamily investment firms. My firm lives and breathes the multifamily market every day. Based on my experience in this sector, there’s more to be learned from the current trends as investors and owners look to what’s around the corner.
Multifamily Apartment Pricing
In clear contrast to rent collection trends, multifamily apartment pricing has gone up dramatically over the past year. Typical multifamily apartment property pricing has compressed from a 5.25%–6.25% cap rate one year ago to a 4.00%–5.00% cap rate today, roughly 125 basis points (bps) of cap rate compression.
Similarly, workforce housing apartments that rent for around $800 per month have increased from $60,000–$70,000 per unit one year ago to $85,000–$100,000 per unit today. Clearly, lower interest rates (agency rates have fallen from about 4.25% one year ago to about 2.90% today) have driven at least part of this cap rate compression.
This dichotomy between multifamily apartment pricing and on-the-ground fundamentals is concerning for multifamily apartment professionals and investment firms, particularly those looking to grow their portfolios in the year ahead. Indeed, near-term fundamentals will be stretched significantly to meet higher expenses and greater debt service requirements – even with lower interest rates.
Despite these near-term concerns, intermediate- and long-term prospects for the multifamily sector remain strong for several reasons:
• Incomes are growing, even at lower demographic rungs, leading to higher rent affordability.
• Home prices have increased (paywall) even more than incomes, pricing out much of the U.S. population and making these people renters by necessity.
• Demographic trends are favorable, including aging baby boomers moving into apartments and young people believing in increased mobility and flexibility and less ownership of “stuff,” manifesting in the prevalence of the sharing economy.
• Construction costs have increased significantly in recent years, and especially this year with Covid-19 impacts, making the existing workforce and value-add apartment opportunities that much cheaper in comparison.
• It’s difficult to see interest rates rising more than 50-75 bps anytime soon.
Some longer-term risks exist, and these mainly revolve around:
• “Cancel Rent” and other political movements that can impact landlords’ ability to operate.
• Eviction moratoriums and other legally contestable policies.
• Rent control laws that restrict returns on property investment and weaken property owners’ rights.
• The tremendous growth in expenses, including property tax, insurance and labor expenses.
Several of these risks are found in greater concentrations in places like California, Oregon, Washington and New York, and much less so in Texas, Florida, North Carolina, South Carolina and Georgia. It’s not surprising that investment dollars have been flowing toward the Sunbelt states.
Given the tremendous changes brought about by the Covid-19 pandemic, investors and operators both have the opportunity to assess where things stand in relation to current trends. Do you have enough exposure to real estate and other brick-and-mortar assets, given low yields in the marketplace and the high price of equities today? Are you optimally exposed to locations that are seeing the biggest demographic population and job growth, like those in Texas and Florida? Is your exposure between suburban and urban rightsized? Is your exposure between luxury and workforce assets appropriate?
Despite the challenges seen over the past year, we remain firm believers in the multifamily apartment sector. We’re continuing to buy apartment properties that meet our acquisition criteria and taking a disciplined and long-term approach to strategic acquisitions.
The apartment space is less efficient – and less liquid – than the stock market, but it is highly predictable and repeatable. This means you have more ability to control the results you deliver for yourself and other investors. The multifamily apartment space has shown that it is essential, and this dynamic is not going away anytime soon.